4 Red flags after recent stock market rally

Indian shares are among the top performers in the world in 2017. The S&P BSE Sensex breached the 30,000-mark recently. On the other hand, the Nifty closed above the 9,200 mark for the first time ever. Midcap shares have outperformed frontline ones. However, there are a few red flags ahead.

Here are pointers that explain the market rally:

Corporate performance expectation:

Revenue growth at companies, other than financial services and energy, is expected to be 8.5% in the fourth quarter to March 2017, according to CRISIL, an independent research firm. However, operating profit margins are expected to be under pressure. For example, the competitive pressure in the telecom sector would lead to sharp profit margin erosion in telecom companies. Higher raw material prices than previous quarters would mean a downward pressure on margins of automobiles, consumer and tyre sectors. Export-oriented companies are also expected to face headwinds with the rupee appreciating sharply during the quarter.

Rupee and foreign flows:

A significant factor for shares to gain during the quarter to March 2017 was liquidity from foreign institutional investors. Close to $13bn was brought in by FIIs in equity and debt markets. This resulted in the rupee becoming one of the top 5 performers in 2017. While a rising rupee makes imports cheaper, it hurts exports as well. As it is, the export sector is witnessing sluggishness due to low demand from the rich countries. Our analysts say that the current gap between two-year real interest rate returns in India and US is 3.3%. Many FIIs are buying Indian government bonds to benefit from this difference. They say that the short-term capital flows could reverse as the gap narrows due to a rise in US interest rates.

Midcap stocks:

The Nifty Midcap index has jumped 23% in 2017 against an 11.5% gain in the Nifty. This means midcap shares have a significant run-up in the share price in comparison to large-cap shares. Our analysts find valuations of several mid-cap shares that they cover to be very high. “It would not be wrong to say that some are in the ‘bubble’ phase with the market extrapolating strong growth and high returns in perpetuity,” said a Kotak Securities report.

GST implementation:

After years of deadlock and stagnancy, the Goods and Services Tax (GST) bill is close to implementation. It is believed that the central government may roll out the bill from as early as July 2017. This has caused great cheer among consumers and investors alike. The GST is expected to boost economic growth in the country by improving business sentiment all around. The Indian Finance Minister, Arun Jaitley has stated that implementation of GST will boost GDP growth by 1-2% in 2017. This stable and transparent tax regime has encouraged more Foreign Direct Investments (FDI) in addition to domestic investments in capital markets. However, any setback to the GDP schedule could hurt the market sentiment this year.

Indian companies highly optimistic of economic recovery in 2017 Read more

Rs. 30,906 Crore

The total FII investments in equity and debt in the month of March 2017 was equal to Rs 55,441 crore, Sebi data reveals. About two-third or Rs 30,906 crore was the inflow in the equity market. This was a key driver for the rally in the stock market.

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